The Art of Unethical Investing

LONDON -- Ethical investing -- where you avoid investing in businesses that engage in activities that you disapprove of -- was first practiced by the Quakers in 1758 when they disinvested from the slave trade. It took off in the 1970s, spurred on by the anti-apartheid movement, and most large fund management groups nowadays offer ethical investment funds.

The problem is that the definition of "ethical" is highly subjective -- and companies that some investors say are "unethical," such as those operating in the alcohol, defense, and oil industries, often beat the market.

"Unethical" is often very profitableIt is generally accepted that one of the most unethical industries is tobacco, if only because, for several decades, some tobacco companies deliberately concealed their knowledge about the damaging effect that tobacco has upon users' health.

Tobacco is, however, a very profitable business, and many years ago Warren Buffett summed up its attraction when he said: "It costs a penny to make. Sell it for a dollar. It's addictive. And there's a fantastic brand loyalty."

This quote, along with the fact that globalization has boosted the incomes of several billion people in the developing world and thus given them the opportunity to acquire a smoking habit, pretty much sums up the case for owning shares in British American Tobacco (ISE: BATS.L) and Imperial Tobacco (ISE: IMT.L) .

Buffett has modified his stance since then, and I believe that nowadays his company doesn't have any major investments in tobacco companies. One company he favors is an attractive large-cap right here in Britain and you can discover what he bought and the price he paid in this special report -- "The One UK Share Warren Buffett Loves" -- it's free.

Shares trading at a small discount?In theory, because ethical investors won't touch companies that they consider to be unethical, this should reduce the demand for their shares. So they should trade at a slight discount to the price where they would otherwise be if these same investors were prepared to buy them. This means that a new investor gets a little bit of a bargain, or at least a higher dividend than he'd otherwise receive.

Sometimes companies are occasionally tarred with the unethical brush because of intermittent behavior, such as GlaxoSmithKline (ISE: GSK) , which was recently fined $3 billion for aggressive sales practices and holding back clinical data. Often when this happens, it throws up a buying opportunity as the news depresses the share price.

While pharmaceutical companies have been known to engage in some questionable practices, the benefits they provide to society massively outweigh the detriments.

Not so clear cutIt's easy for a company to get some good publicity by slapping on a bit of green paint and announcing an environmental initiative. This is called "greenwashing," and it often works as many people pay little or no attention to the difference between actions and words.

The oil supermajor BP (ISE: BP.L) has given itself a greener tinge over the last decade, and since 2001 BP has officially stood for "Beyond Petroleum." While BP won't appear on most ethical investment managers' lists, especially after the Deepwater Horizon disaster, a surprisingly large number of them own shares in BP and many other companies that they are supposed to avoid if they follow their own ethical criteria.

This reminds me of St. Augustine of Hippo who in his youth said "Lord, make me pure ... but not yet."

Everyone is unethicalI reckon that every company in the FTSE 100 index could be called "unethical" if you look hard enough with a critical eye. It's hard to beat HSBC Holdings (ISE: HSBA.L) in this category after this week's revelation that it has been helping organized crime groups, terrorists, and rogue regimes to launder and transfer money.

But the line between ethical and unethical behavior isn't quite as clear as you might think, because some companies that trumpet their ethical credentials have been known to also behave in a distinctly unethical manner. One way in which they do this is to get someone else to do those things that violate their ethical policies, such as buying palm oil from a supplier who forcibly evicted peasant farmers to make way for the plantations.

For some people, if a company operates in the developing world, that is more than enough to call it "unethical." I'm happy to invest in these companies as I see nothing unethical about raising living standards in poorer countries.

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Tony owns shares in GlaxoSmithKline but he doesn't own shares in any of the other companies that are mentioned in this article. He won't invest in tobacco, though he did used to own shares in a company that makes guided missiles. The Motley Fool has adisclosure policy.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.